Economics Chapter 2
Scientific Method: The dispassionate development and testing of theories on the workings of the
universe. Since experiments are very difficult to conduct in economics, economists use historical events
as natural experiments. Ex. Decrease in house in sales after interest hike
Assumption: is used to simplify complexity of the world. Ex. To study consumption behaviour, we may
assume there are only 2 goods. Unrealistic, but will give a valuable insight on consumption behaviour.
Economic Model: is an explanation of workings of an economic phenomenon, based on simplifying
Circular-Flow Diagram: a visual model of the economy that shows how dollars flow through markets
among households and firms
Factors of production: are the inputs that are necessary for production such as land, labour and capital
In the market for goods and
services, households are buyers and
firms are sellers.
In the market for factors of
production, households are sellers and
firms are buyers.
If you trace a loonie in the economy
for period of time, it will be used in
transactions in the above two markets
Production Possibilities Frontier (PPF): is a graph that represents all the possible combinations of goods
the economy can produce, given the available factors of production & available production technology.
We assume that there are 2 goods. Since the factors of production are limited in quantity, not every
combination of goods is feasible. Opportunity cost is what you have to give up in order to obtain something.
If economy moves from one efficient point to other on the PPF, it faces a trade-off. Inc